Saturday, March 19, 2011

The mortgage interest deduction: for or against?

This is the kind of topic I really enjoy discussing: one which I don't have a strong feeling about (while others do); one which I can agree with the arguments on each side; and one which the usual liberal/conservative pros and cons don't easily apply.

Recently some folks at SaveMyMID.com have been asking me to blog on the issue, so I encouraged them to submit a guest post. As background, know that Rep. Gary Miller of California is sponsoring legislation to protect the mortgage interest tax deduction, and in 2007 Rep. John Dingell (D-MI) proposed a bill to repeal it. Miller is not only as solid a right-winger as the Right could hope for, he's also a shady developer from way back. CREW even lists him as one of Congress' most corrupt members. (The only Texan that makes their list is Pete Sessions, which is amazing in its own right.) Dingell, 84, is one of Congress' oldest and longest-serving members, was the chair of the House Energy and Commerce committee when the Dems were still the majority, and survived a tough challenge last November to earn a 28th term. That makes this his 55th year in the House of Representatives (but who's counting).

The phase-out schedule (begins) with houses of 3,000 square feet, which would lose 15 percent of their deductions, and ending with houses of 4,200 square feet and larger, which would receive no deductions at all.

“In order to address the issues of climate change, we must address the come forth of consumption -- we do that by making consumption more expensive,” Dingell said.

Then along came the housing market bust, of course, and in the interest of reviving the economy talk of the MID went away. But Obama's budget revives and expands it, particularly on the wealthy, who are still building large homes despite the Great Crash of 2010 2008.

The Obama administration hopes to tap the rich to help pay for its ambitious programs. Specifically, that would include slashing mortgage interest deductions for high-income taxpayers.

The proposal would cap at 28% the tax break for itemized deductions.

That would leave people in higher marginal tax brackets of 33% and 35% - the wealthiest Americans -- with a smaller benefit from the deduction of mortgage interest, state and local taxes and other items such as charitable contributions.

The move is projected to raise $318 billion over 10 years and fits nicely with the president's campaign pledge to increase taxes only for families earning more than $250,000. Few, if any middle-income homeowners are in tax brackets of more than 28%.

Dean Baker, co-director of the Center for Economic and Policy Research, a D.C. think tank, said he was impressed with this part of the budget plan.

"It's a no-brainer for economists," he said. "Why have taxpayers been [in effect] subsidizing home payments for the highest income people in the country?"

Contrary to assertions by some economists, the income tax deductions for mortgage interest and real estate taxes primarily benefit middle class taxpayers with incomes between $50,000 and $200,000, according to the findings of a study by the National Association of Home Builders. Taxpayers earning less than $200,000 pay 43 percent of all income taxes. However, they receive 68 percent of the total benefit of the mortgage interest deduction and 77 percent of the total benefit of the real estate tax deduction.

Moreover, larger benefits go to larger households and families, such as those with children. And as a share of household income, larger benefits are collected by families with less than $200,000 income, indicating that these tax rules make the tax system more progressive. Ever since the federal income tax was introduced in 1913, the government has used the tax code to encourage homeownership. Now, as a result of the effort to reduce the federal deficit, the mortgage interest deduction is under fire. Proposed changes to the tax code would have a dramatic impact on homeowners and would significantly reduce the value of this deduction.

Suppose a home owner paying $10,000 in mortgage interest in a year faces a marginal tax rate of 25 percent and, to keep things simple, has enough other itemized deductions that they would itemize regardless of the mortgage interest deduction. For that homeowner, the mortgage interest deduction is worth approximately 25 percent times $10,000 or $2,500 in reduced taxes paid. With a 12 percent tax credit, the homeowner’s tax benefit would be reduced to $10,000 times 12 percent or $1,200.

Moreover, if other proposals affecting housing-related deductions went into effect, home owners would not be able to deduct their state and local property taxes or the interest on any home equity loan they might have and they would pay higher tax on a principal residence when sold.

Next time a right-winger complains about entitlements, ask him or her to not take the mortgage deduction on their taxes.

A liberal responds:

FWIW this is a deal-breaker for me. I will probably vote against anybody who supports repealing the mortgage deduction.

OTOH, the mortgage deduction doesn't meet the definition of an "entitlement", just like social security doesn't. Neither are entitlements. I believe that as part of our social safety net, we SHOULD have some entitlements, however... the mortgage deduction is not an entitlement in the first place.

Sure sounds like you are treating it like it is.

Nope. Here's the distinction.

I made an important INVESTMENT decision based on the deduction. I would have made a different investment decision (a different mortgage, house etc.) if it wasn't there. The mortgage interest deduction is no more an entitlement than the lower tax rate for capital gains vs. income is. It's about trade-offs, and if they change the rules in the middle of the game, I call foul. If they changed the rule for all NEW mortgages, that would be different.

It's not an entitlement, it's a tax incentive based on one type of investment vs. another.

More along that vein.

The mortagage deduction should be repealed.

It is corporate welfare for the banking and real estate industry. It causes the prices of houses to be inflated beyond their worth ("Look at all the money you will save by taking the mortgage deduction!"). If the deduction were eliminated the houses would come down in price because people would not be tricked into taking loans which they can't afford. Get rid of it.

Wrong on two points.

First, it doesn't help banks at all; they charge the same interest rate whether you deduct interest from your taxable income or not. It does help a potential homeowner by lowering the net cost of owning a home. Second point, I don't see how people are being "tricked" into taking out loans they can't afford and why would a bank want that? If you can't afford your home loan and default on it, then the bank has to foreclose on the house and they'll probably lose a lot of money. If you're too dumb to make an intelligent decision about whether you can afford a mortgage, you shouldn't be borrowing money -- period.

Brokers/originators don't care if the loan is repaid or not. Fees/commissions for the mortgage originator are paid upfront with the closing costs. True, the mortgage lender suffers from a default. But by that time the originator is long gone from the transaction.

So what? The bank makes the final decision about whether to lend the money.

Based on what the originator tells them (my note: more accurately, the information collected by the originator, furnished by the borrower. Which could be manipulated by either/both for a favorable outcome). No investor intentionally bought bad paper. It was all funneled through secondary markets, changing hands several times before being bundled and sold as securities for investors. Hence the culprits had plausible deniability for passing the bad paper. In the end they stuck the bill to the US taxpayer.

Maybe the banks did crappy due diligence or maybe the originator committed fraud. The fix for those problems is not to bail out the banks and the securities firms and to prosecute fraud if and where it occurred. That is unrelated to whether mortgage interest should be deductible for the borrower.

I just can't argue with any of this so far. Here's something else.

The mortgage crisis is separate from the tax issue.

The former results from a system that placed rewards upon certain transactions without sufficient oversight to ensure that impropriety wasn't taking place. Such as an accurate rating of mortgage backed securities. And our legislative history of allowing large corps to privatize profits while socializing losses.

Interest deduction on taxes was originally intended to prevent the money from being taxed twice. Once by the Payee and again by the Lender. During the Reagan administration the rules were changed, and most loan interest was no longer tax deductible. The exception being the 'Interest on Primary Residence' and a secondary residence. Then the tax lawyers found ways to start incorporating home improvement loans into mortgages and others went further, selling HILs with the pitching of buying big-ticket items with the money.

Going back to the pre-Reagan view IMO is the right choice. Let everyone get the deduction for interest and avoid paying tax twice on the interest.

Finally, some of this.

Sorry chum, but us poor folks who are holding on to our homes by the finger nails use the mortgage interest deduction tax. Sure, it's only a little over $2,000 per year that I'm saving from adding to my income taxes, but every little bit helps.

If they change it, lots of middle class folks will see a HUGE tax increase.

You'd have to phase it out over time because people who bought their home calculated that into the decision, and you have to give them enough time to make a change. And in this housing environment, selling or refinancing is very tough for the middle class.

A wealthy family will have no problem restructuring their debt.

There are several classic confrontations inherent in the MID conversation, from economic vs. enviromental and tax cut vs. tax increase as well as the social and class concerns.

So is the mortgage deduction regressive, as some would seem to suggest? Do you favor it or oppose it? Are you a homeowner or not (or a Realtor or a banker or a lender, for that matter)?

FTR I am not a homeowner and never have been. I HAVE worked as a loan originator and my wife as a banker, mostly as an originator herself, though she has the experience of a big bank's deliberations in loan approval. I think I quite clearly see the pros and cons of both sides and lean in favor of reducing and/or phasing out mortgage interest deductions, most particularly on larger more expensive homes (as well as taxpayers). But I'm capable of being swayed by almost any argument.

At the end of April, I will have been a homeowner for one year. We are solidly middle class and if you look up the "average" price of a home in Houston, that's what we paid (at least based on the last numbers I saw).

When we bought our house after being renters for decades combined (I'm in my mid-30s, my partner in her mid-40s) we considered a lot of factors, one of which was the mortgage interest deduction (the other which influenced when we bought was the home buyer's credit).

In theory, I can see both sides of this issue and could get on board with eliminating this deduction. I understand all the arguments for it.

In practice, however, we did count on the deduction when thinking about our yearly finances when considering buying our home. We are solidly middle class -- both working in public education in some way -- and the interest deduction is important to us.

Now that Texas is approaching the benchmark that 50% of families rent, is this a fair deduction or a subsidy for landlords? I rent now but I have owned in the past and appreciated the deduction. I also owned rental homes at one time and the deductions really added up, with deprecation,to helpt reduce my taxable income to the 15% bracket. But all the homes rented for less than the note on them (the renters were building the equity better than the loss invested in the market would pay). It would certainly change the balance sheet on property owners.Im conflicted on this one.